KBRA Affirms Ratings for FirstSun Capital Bancorp; Places Ratings for HomeStreet, Inc. on Watch Developing Following Merger Announcement
18 Jan 2024 | New York
KBRA affirms the senior unsecured debt rating of BBB, the subordinated debt rating of BBB-, and the short-term debt rating of K3 for Denver, Colorado-based FirstSun Capital Bancorp (OTCQX: FSUN) ("FirstSun") following the proposed merger announcement with Seattle, Washington-based HomeStreet, Inc. (NASDAQ: HMST) ("HomeStreet"). Additionally, KBRA affirms the deposit and senior unsecured debt rating of BBB+, the subordinated debt rating of BBB, and the short-term deposit and debt ratings of K2 for its subsidiary, Sunflower Bank, N.A. The Outlook for all long-term ratings is Stable. KBRA also places the ratings on Watch Developing for HomeStreet, Inc., including the senior unsecured debt rating of BBB-, the subordinated debt rating of BB+, and short-term debt rating of K3, as well as the deposit and senior unsecured debt ratings of BBB, the subordinated debt rating of BBB-, and the short-term deposit and debt ratings of K3 for its subsidiary, HomeStreet Bank.
Key Credit Considerations
On January 16, 2024, FirstSun Capital Bancorp and HomeStreet, Inc. announced the signing of a definitive merger agreement, pursuant to which the companies will combine in an all-stock transaction that is expected to close in mid-2024. HomeStreet is expected to merge with and into FirstSun, and HMST's subsidiary, HomeStreet Bank, will merge with and into FSUN's subsidiary, Sunflower Bank, N.A., though HomeStreet will maintain its brand within its legacy markets. The transaction was valued at $286 million or 0.56x P/TBV at merger announcement. Moreover, the transaction also includes a $175 million in capital commitments from an investor group led by Wellington Management, with $80 million of the total invested at the time of announcement, while the remaining $95 million is expected to fund at merger close. As such, the ownership of the combined entity will be as follows: FirstSun (64%), HomeStreet (22%), Wellington (9%), and Other Investors (5%). The Other Investor Group is expected to be announced in form 8-K in coming days, though management noted that the commitments are fully subscribed. The combined entity will largely retain FSUN's current leadership as its executive team, including FirstSun's CEO, Neal Arnold, and CFO, Robert Cafera, with HMST's CEO, Mark Mason, joining as Vice Chairman of the Board. HomeStreet is also expected to have 3 seats of 12 on the Board of Directors. Additionally, following the close of the merger, FirstSun will be listed on NASDAQ.
Overall, assuming effective integration of the merger, which we believe has a high likelihood given FSUN's strong track-record with regard to M&A, specifically turning around underperforming CRE-focused institutions, KBRA positively views the transaction, which is expected to add distinguished institutional investors as meaningful prospective shareholders. The pro forma company is expected to have $17.0 billion in total assets, including $13.1 billion of deposits, and $13.7 billion of loans, with 129 branches spread across a 9-state footprint, most notably in the Southwest, Southern California, Pacific Northwest, and Hawaii. While KBRA favorably views the geographic diversity of the combined franchise, we also acknowledge that the footprint is comparatively scattered without meaningful market share established in most of the major MSAs in footprint. However, the company is well positioned for future growth as it is situated in 8 of the 10 largest MSAs in the Western & Central U.S. With regard to the balance sheet, despite the combined company reflecting a higher concentration in time deposits (36% of total), the cost of deposits is projected to remain relatively in line with similarly rated peers as both institutions maintained a cost of deposits of ~2% for 3Q23. Moreover, we also acknowledge that the combined entity will have a significant amount of balance sheet flexibility given that HMST's assets will be marked-to-market (MTM), which will provide liquidity to potentially de-lever and allow for some higher-cost funding to exit the bank. Another positive is that the pro forma company's deposit franchise will be seasoned and granular, with an average account size of $32k, weighted average age of 8.7 years, and uninsured deposits reflecting just 20% of total at closing. Given HomeStreet's concentration in multifamily lending (51% of total as of 3Q23), this asset class will remain the largest segment of the combined company's loan portfolio (projected to be 29%), though C&I will remain a material contributor at 28% of total loans and will continue to be emphasized moving forward through the hiring of new talent in HMST's legacy markets. Moreover, the investor CRE concentration is projected to remain below average at 157% of total risk-based capital at closing (excluding multifamily).
The pro forma full year (2025) financial metrics are expected to be relatively strong, including a ROA nearing 1.4%, which will be supported by a healthy NIM of 3.9%, though admittedly will be reinforced by a significant level of purchase accounting accretion income as the transaction includes a $420 million pre-tax write down on HMST's loans, and $88 million after-tax loss on HomeStreet's securities portfolio. Moreover, KBRA views the business model and balance sheets from the respective institutions as complementary, with the combined entity moving more toward a neutral positioning to IRR management, as the liability sensitive nature from HMST due to its mulitfamily portfolio will be offset by the asset sensitivity from FSUN due to its largely C&I and floating rate loan portfolio. This positions the company well from an interest rate standpoint given the potential for rate cuts in 2024 and 2025. Additionally, revenue diversity is expected to remain solid, with noninterest income representing 22% of total revenues, with mortgage banking GoS comprising just 5% of total revenues. While the impact of higher interest rates has yet to materially impact most of KBRA rated institutions from a credit quality perspective, there remain many uncertainties in the industry over the near-term, though we believe that the combined company will reflect a lower credit risk profile. This is attributable to the aforementioned below average exposure to investor CRE, notably a nominal concentration in the troubled office sector, as well as disciplined underwriting practices. Moreover, the deal included a gross credit mark of ~$80 million (1.1% of loans), which we view as conservative in the context of HMST's loan portfolio, which as noted, was largely concentrated in multifamily that has reflected virtually no losses over the years. As such, the LLR to total loans is expected to increase just above 1.2% on a combined basis (1.5% excluding multifamily). The biggest concern for the company following the close will be the decrease in capital ratios given HMST's below peer capital position pre-merger and the MTM impact, including a pro forma CET1 ratio of 9.1%. However, with the enhanced earnings capacity post-merger, FSUN will have the ability to generate internal capital quickly, with the forecasts showing meaningful growth in the CET1 ratio in 2025 (10.7% by YE25). The liquidity position as measured by the loan-to-deposit ratio is projected to remain elevated at approximately 100% at closing, though management intends to manage that ratio in the low-to-mid 90% level over time. KBRA acknowledges the risks associated with a large-scale acquisition including regulatory approvals, etc.; however, we view FSUN’s management team as very experienced with regard to integrating acquisitions and fully realizing the merger benefits.
An upgrade for FSUN's ratings is not expected in the near-term, though successful integration of the HMST acquisition and the realization of operating leverage, resulting in solid core earnings performance, adhering to capital rebuild targets, while maintaining its solid core deposit franchise without credit deterioration negatively impacting the earnings/capital profile, could support positive rating momentum over time. Conversely, negative rating action is not expected, though if capital is sustained below current levels for a period of time (<10% CET1 ratio), or if asset quality issues arise and weigh on earnings, or if the funding/liquidity positions were to materially weaken, then the ratings could be pressured.
The successful completion of the merger would result in a resolution of HMST's Watch Developing status, in which the ratings and Outlook would likely be equalized with FSUN's. Should the merger not close as planned, KBRA would revisit HMST's stand-alone ratings.
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